Deck 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach

Question 1

One rational for using expected dividends in valuation is

A) Dividends are a necessary payment in order for a firm to have value.
B) Dividends are paid in cash, and cash serves as a measurable common denominator for comparing the future benefits of alternative investment opportunities.
C) Dividends are the most reliable measure of value because most companies payout dividends to shareholders.
D) Dividend payout ratios are set based on profitability.

Answer 1

B

Question 2

One criticism in using the CAPM to calculate the cost of equity capital is that ______________________________ and the __________________________________________________ are quite sensitive to the time period and methodology used in their computation.

Answer 2

market betas, excess market rate of return

Question 3

When deriving the equity value of a firm an analyst forecasts the real dividends expected to be paid in the future. In this case which discount rate should be used?

A) The nominal rate of return
B) The real rate of return
C) The risk free rate of return
D) The risk adjusted rate of return

Answer 3

B

Question 4

In theory, the value of a share of common equity is the present value of ____________________________________________________________.

Question 5

Suppose a firm has a market beta of 1.34 and the risk free interest rate is 5.3%. In addition, the excess return over the risk-free rate is 5.9%. Calculate the firm's cost of equity capital using the CAPM model.

Question 6

Zolar Corp. The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions):
Assuming that riskless rate is 4.2% and the market premium is 6.2% calculate Zolar's cost of equity capital:

A) 10.4%
B) 7.69%
C) 11.89%
D) 2.0%

Question 7

Zolar Corp. The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions):
Using the above information, calculate Zolar's weighted-average cost of capital:

A) 11.5%
B) 11.89%
C) 7.48%
D) 10.90%

Question 8

Equity based valuation models are based on all metrics except

A) dividends
B) cash flow
C) working capital
D) earnings

Question 9

Zolar Corp. The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions):
Determine the weight on debt capital that should be used to calculate Zolar's weighted-average cost of capital:

A) 21.7%
B) 78.3%
C) 50%
D) 58.2%

Question 10

Normally, valuation methods are designed to produce reliable estimates of the value of a firm's ______________________________.

Question 11

Dividends measure the cash that ____________________ ultimately receive from investing in an equity share.

Question 12

In some valuation scenarios, such as a leveraged buyout, it may be necessary to adjust the market equity beta to reflect a ________________________________________.

Question 13

Which of the following is not a problem with using a dividend-based valuation formula

A) dividends are arbitrarily established
B) dividends represent a transfer of wealth to shareholders
C) some firms do not pay a regular periodic dividend
D) it is a challenge to forecast the final liquidating dividend

Question 14

If dividend projections include the effect of inflation then the discount rate used should be a ____________________ rate.

Question 15

Zolar Corp. The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions):
Assume that Zolar is a potential leveraged buyout candidate. Assume that the buyer intends to put in place a capital structure with that has 70 percent debt with a pre tax borrowing cost of 14 percent and 30 percent common equity. Compute the weighted average cost of capital for Zolar based on the new capital structure.

A) 20.63%
B) 12.56%
C) 13.01%
D) 9.94%

Question 16

Zolar Corp. The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions):
Determine the weight on equity capital that should be used to calculate Zolar's weighted-average cost of capital:

A) 21.7%
B) 78.3%
C) 41.8%
D) 50%

Question 17

Zolar Corp. The following data pertains to Zolar Corp., a manufacturer of ball bearings (dollar amounts in millions):
Assume that Zolar is a potential leveraged buyout candidate. Assume that the buyer intends to put in place a capital structure with that has 70 percent debt with a pre tax borrowing cost of 14 percent and 30 percent common equity. Compute the revised equity beta for Zolar based on the new capital structure.

A) 1.24
B) 4.77
C) 4.34
D) 3.91

Question 18

To determine the appropriate weights to use in the weighted average cost of capital, an analyst will need to determine the ______________________________ of the debt, preferred stock and common equity capital.

Question 19

Because the market equity beta reflects the level of operating leverage, financial leverage, variability of sales and other characteristics of a firm there are situations where an analyst might have to adjust the beta because of changes in the capital structure. A situation that might require an analyst to estimate a new levered beta is a ___________________________________.

Question 20

A company with a market beta of 1 has systemic risk ____________________ to the average amount of systemic risk of all equity securities in the market.

Question 21

In what case will using dividends expected to be paid to shareholders yield the same valuation for the firm as using free cash flows expected to be generated by the firm?

Question 22

LA Sunglasses operates retail sunglass kiosks in shopping malls. Below is information related to the company:
Using the above information and assuming that steady-state growth in year 2012 and beyond will be 4% calculate LA Sunglasses value per share.

Question 23

Implementing a dividend valuation model to determine the value of the common shareholders' equity requires an analyst to measure three elements. Discuss what three elements need to be measured by the analyst.

Question 24

WACC
An analyst wants to value the sum of the debt and equity capital of the firm and is provided with the following information:
An analyst wants to value the common shareholders' equity of Bridgetron, compute the relevant cost of capital that should be used.

Question 25

Under the assumption of clean surplus accounting how would you compute total dividends paid to common equityholders in order to value the firm?

Question 26

For each of the following scenarios determine the value as of the beginning of 2007 of the continuing dividend:

Question 27

The following financial statement data pertains to Jane's Coats, a manufacturer of women's outerware (dollar amounts in millions):
Required:

Question 28

For each of the following companies determine the total dividends paid to common equity holders in order to value the firm:

Question 29

Provide the rationale for using expected dividends in a valuation model.

Question 30

The following data pertain to LDP Corporation
(dollar amounts in thousands)
Using the information pertaining to LDP Corporation calculate the following information: